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SFG > SEC Filings for SFG > Form 10-K on 26-Feb-2014All Recent SEC Filings

Show all filings for STANCORP FINANCIAL GROUP INC

Form 10-K for STANCORP FINANCIAL GROUP INC


26-Feb-2014

Annual Report


ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following management assessment of the financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes thereto contained in Item 8, "Financial Statements and Supplementary Data." Our consolidated financial statements and certain disclosures made in this Form 10-K have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") and require us to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosures of contingent assets and contingent liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during each reporting period. The estimates most susceptible to material changes due to significant judgment are identified as critical accounting policies. The results of these estimates are critical because they affect our profitability and may affect key indicators used to measure our performance. See "Critical Accounting Policies and Estimates."

Financial measures that exclude after-tax net capital gains and losses and accumulated other comprehensive income ("AOCI") are non-GAAP measures. To provide investors with a broader understanding of earnings, we provide net income per diluted share excluding after-tax net capital gains and losses, along with the GAAP measure of net income per diluted share, because capital gains and losses are not likely to occur in a stable pattern.

Management believes that measuring return on average equity excluding after-tax net capital gains and losses from net income and AOCI from equity is important to investors because the turnover of our portfolio of fixed maturity securities may not be such that unrealized gains and losses reflected in AOCI are ultimately realized. Furthermore, management believes exclusion of AOCI provides investors with a better measure of return.

This management's discussion and analysis of financial condition and results of operations contains forward-looking statements. See Part I, Item 1A, "Risk Factors-Forward-Looking Statements."

EXECUTIVE SUMMARY

StanCorp Financial Group, Inc., through its subsidiaries marketed as The Standard - Standard Insurance Company ("Standard"), The Standard Life Insurance Company of New York, Standard Retirement Services, Inc. ("Standard Retirement Services"), StanCorp Mortgage Investors, LLC ("StanCorp Mortgage Investors"), StanCorp Investment Advisers, Inc., StanCorp Real Estate, LLC and StanCorp Equities, Inc. ("StanCorp Equities") - is a leading provider of financial products and services. StanCorp's subsidiaries offer group and individual disability insurance, group life and accidental death and dismemberment insurance ("AD&D"), group dental and group vision insurance, absence management services, retirement plans products and services, individual annuities, origination and servicing of fixed-rate commercial mortgage loans and investment advice.

Financial Results Overview

The following table sets forth selected consolidated financial results:



                                                                   Years ended
                                                                  December 31,
(Dollars in millions except share
data)                                          2013                   2012                   2011


Net income                                $        228.5         $        138.5         $        136.7
After-tax net capital losses                        (9.4)                  (5.4)                  (4.5)


Net income excluding after-tax net
capital losses                            $        237.9         $        143.9         $        141.2

Earnings per diluted common share:
Net income                                $         5.13         $         3.12         $         3.04
After-tax net capital losses                       (0.21)                 (0.12)                 (0.10)


Net income excluding after-tax costs
net capital losses                        $         5.34         $         3.24         $         3.14

Diluted weighted-average common
shares outstanding                            44,527,405             44,359,891             45,016,070

Net income excluding after-tax net capital losses was $5.34 per diluted share for 2013, compared to $3.24 per diluted share for 2012. The increase was primarily due to more favorable claims experience in Employee Benefits, lower operating expenses as a result of expense management actions, and higher earnings in the Asset Management and Individual Disability segments for 2013. Operating expenses were reduced by $20.6 million or $0.30 per diluted share for the first half of 2013 due to the amendment of the postretirement medical plan.

Net income excluding after-tax net capital losses was $3.24 per diluted share for 2012, compared to $3.14 per diluted share for 2011. The increase was primarily due to higher net investment income from bond call premiums and commercial mortgage loan prepayment fee revenues, higher premiums for Employee Benefits and Individual Disability, a lower effective income tax rate and higher earnings in

18 STANCORP FINANCIAL GROUP, INC.


Table of Contents

Asset Management. The increase was partially offset by a comparatively higher Employee Benefits benefit ratio as a result of a 95 basis point lower average discount rate in 2012 compared to 2011 used for newly established long term disability claim reserves.

Primary Drivers of 2013 Results and Outlook for 2014

We reported higher earnings in all of our businesses in 2013 compared to 2012. The primary drivers of our results for 2013 were the favorable claims experience in Employee Benefits, lower operating expenses as a result of expense management actions and higher earnings in our Asset Management and Individual Disability segments. We returned over $130 million of capital to shareholders through dividends and share repurchases.

The annual Employee Benefits benefit ratio was 78.9% for 2013, compared to 83.9% for 2012. The decrease in the annual benefit ratio was primarily due to pricing actions implemented on our long term disability business and an improvement in long term disability claims incidence. The annual Individual Disability benefit ratio was 63.9% for 2013, compared to 65.8% for 2012. Claims experience can fluctuate widely from quarter to quarter and tends to be more stable when measured over a longer period of time. Operating expenses were reduced by $20.6 million for the first half of 2013 due to the amendment of the postretirement medical plan. Asset Management reported income before income taxes of $79.3 million for 2013, compared to $64.0 million for 2012. The increase was primarily due to higher administrative fee revenues as a result of the increase in assets under administration and lower benefits to policyholders as a result of favorable mortality experience in the individual annuity business.

We are seeing the benefits of a slowly improving economy as well as actions within our Employee Benefits businesses now that we are nearly complete with our re-pricing efforts related to higher long term disability claims incidence.

These results show our commitment to our strategy of obtaining and retaining profitable business. As we look to 2014, we will face ongoing macro-economic factors: a persistent low interest rate environment, a price sensitive group insurance marketplace, elevated unemployment levels and challenges to wage and employment growth of our customers. Despite these challenges, we will continue to focus on our long-term objectives and address challenges that arise with financial discipline and from a position of financial strength. We manage for long-term profitability by focusing on business diversification, disciplined product pricing, sound underwriting, effective claims management and high-quality customer service.

We intend to preserve the value of our business by continuing to provide excellent service to our customers. We will optimize shareholder value through sustainable profitability by investing in new product and service capabilities and through the strategic use of capital. We believe these actions along with our strong performance in 2013 and a slowly improving economy position us well for growth in 2014 and beyond.

For a discussion of our consolidated results of operations and business segment results, see "Consolidated Results of Operations."

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our consolidated financial statements and certain disclosures made in this Form 10-K have been prepared in accordance with GAAP and require us to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosures of contingent assets and contingent liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. The estimates most susceptible to material changes due to significant judgment (identified as the "critical accounting policies") are those used in determining investment valuations, deferred acquisition costs ("DAC"), value of business acquired ("VOBA") and other intangible assets, the reserves for future policy benefits and claims, pension and postretirement benefit plans and the provision for income taxes. The results of these estimates are critical because they affect our profitability and may affect key indicators used to measure our performance. These estimates have a material effect on our results of operations and financial condition.

Investment Valuations

Fixed Maturity Securities

Capital gains and losses for fixed maturity securities are recognized using the specific identification method. If a fixed maturity security's fair value declines below its amortized cost, we must assess the security's impairment to determine if the impairment is other than temporary.

In our quarterly impairment analysis, we evaluate whether a decline in value of the fixed maturity security is other than temporary by considering the following factors:

The nature of the fixed maturity security.

The duration until maturity.

The duration and extent the fair value has been below amortized cost.

The financial quality of the issuer.

Estimates regarding the issuer's ability to make the scheduled payments associated with the fixed maturity security.

Our intent to sell or whether it is more likely than not we will be required to sell a fixed maturity security before recovery of the security's cost basis through the evaluation of facts and circumstances including, but not limited to, decisions to rebalance our portfolio, current cash flow needs and sales of securities to capitalize on favorable pricing.

2013 ANNUAL REPORT 19


Table of Contents

Part II

If it is determined other-than-temporary impairments ("OTTI") exists, we separate the OTTI of fixed maturity securities into an OTTI related to credit loss and an OTTI related to noncredit loss. The OTTI related to credit loss represents the portion of losses equal to the difference between the present value of expected cash flows, discounted using the pre-impairment yields, and the amortized cost basis. All other changes in value represent the OTTI related to noncredit loss. The OTTI related to credit loss is recognized in earnings in the current period, while the OTTI related to noncredit loss is deemed recoverable and is recognized in other comprehensive income. The cost basis of the fixed maturity security is permanently adjusted to reflect the credit related impairment. Once an impairment charge has been recorded, we continue to review the OTTI securities for further potential impairment.

We maintain an internally identified list of fixed maturity securities with characteristics that could indicate potential impairment ("watch list"). At December 31, 2013, our fixed maturity securities watch list totaled $2.4 million at fair value and $2.5 million at amortized cost. We recorded $1.1 million of OTTI related to credit loss due to impairments for 2013, compared to $3.2 million for 2012. We recorded no OTTI related to noncredit loss for 2013 and 2012. See Item 8, "Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 1-Summary of Significant Accounting Policies-Investment Valuations-Fixed Maturity Securities-Available-for-Sale" for further disclosures.

We will continue to evaluate our holdings; however, we currently expect the fair values of our investments to recover either prior to their maturity dates or upon maturity. Should the credit quality of our fixed maturity securities significantly decline, there could be a material adverse effect on our business, financial position, results of operations or cash flows.

In conjunction with determining the extent of credit losses associated with fixed maturity securities, we utilize certain information in order to determine the present value of expected cash flows discounted using pre-impairment yields. Some of these input factors include, but are not limited to, original scheduled contractual cash flows, current market spread information, risk-free rates, fundamentals of the industry and sector in which the issuer operates, and general market information.

Fixed maturity securities are classified as available-for-sale and are carried at fair value on the consolidated balance sheet. See Item 8, "Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 9-Fair Value" for a detailed explanation of the valuation methods we use to calculate the fair value of our financial instruments. Valuation adjustments for fixed maturity securities not accounted for as OTTI are reported as net increases or decreases to other comprehensive income (loss), net of tax, on the consolidated statements of comprehensive income.

Commercial Mortgage Loans

The carrying value of commercial mortgage loans represents the outstanding principal balance less a loan loss allowance for probable uncollectible amounts. The commercial mortgage loan loss allowance is estimated based on evaluating known and inherent risks in the loan portfolio and consists of a general loan loss allowance and a specific loan loss allowance. The general loan loss allowance is based on our analysis of factors including changes in the size and composition of the loan portfolio, debt coverage ratios, loan to value ratios, actual loan loss experience and individual loan analysis. An impaired commercial mortgage loan is a loan where we do not expect to receive contractual principal and interest in accordance with the terms of the original loan agreement. A specific allowance for losses is recorded when a loan is considered to be impaired. We also hold specific allowances for losses on certain performing loans that we continue to monitor and evaluate. Impaired commercial mortgage loans without specific allowances for losses are those for which we have determined that it remains probable that we will collect all amounts due. In addition, for impaired commercial mortgage loans, we evaluate the loss to dispose of the underlying collateral, any significant out of pocket expenses the loan may incur, the loan-to-value ratio and other quantitative information we have concerning the loan. Portions of loans that are deemed uncollectible are generally written off against the allowance, and recoveries, if any, are credited to the allowance. See "Liquidity and Capital Resources-Investing Cash Flows-Commercial Mortgage Loans."

Real Estate

Real estate is comprised of two components: real estate investments and real estate acquired in satisfaction of debt through foreclosure or the acceptance of deeds in lieu of foreclosure on commercial mortgage loans ("Real Estate Owned").

Our real estate investments are stated at cost less accumulated depreciation. Generally, we depreciate this real estate using the straight-line depreciation method with property lives varying from 30 to 40 years.

We record impairments when it is determined that the decline in fair value of an investment below its carrying value is other than temporary. The impairment loss is charged to capital losses, and the cost basis of the investment is permanently adjusted to reflect the impairment.

Real Estate Owned is initially recorded at the lower of cost or net realizable value, which includes an estimate for disposal costs. This amount may be adjusted in a subsequent period as additional information is received. Our Real Estate Owned is initially considered an investment held for sale and is expected to be sold within one year from acquisition. For any real estate expected to be sold, an impairment charge is recorded if we do not expect the investment to recover its carrying value prior to the expected date of sale. Once an impairment charge has been recorded, we continue to review the investment for further potential impairment.

Total real estate was $65.7 million at December 31, 2013, compared to $95.5 million at December 31, 2012. The $29.8 million decrease in total real estate during 2013 was primarily due to the sale of Real Estate Owned and the impairments on Real Estate Owned.

20 STANCORP FINANCIAL GROUP, INC.


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DAC, VOBA and Other Intangible Assets

DAC, VOBA and other acquisition related intangible assets are generally originated through the issuance of new business or the purchase of existing business, either by purchasing blocks of insurance policies from other insurers or by the outright purchase of other companies. Our intangible assets are subject to impairment tests on an annual basis or more frequently if circumstances indicate that carrying values may not be recoverable.

The following table sets forth the net balances of DAC, VOBA and other intangible assets:

                                                                    December 31,
                                                                                      Percent
(Dollars in millions)                                   2013             2012          Change


DAC                                                  $     319.1     $     284.9          12.0 %
VOBA                                                        20.1            23.4        (14.1)
Other intangible assets                                     32.1            38.2        (16.0)

Total DAC, VOBA and other intangible assets, net     $     371.3     $     346.5          7.2

We defer certain acquisition costs that vary with and are directly related to the origination of new business and placing that business in force. Certain costs related to obtaining new business and acquiring business through reinsurance agreements have been deferred and will be amortized to accomplish matching against related future premiums or gross profits as appropriate. We normally defer certain acquisition-related commissions and incentive payments, certain costs of policy issuance and underwriting, and certain printing costs. Assumptions used in developing DAC and amortization amounts each period include the amount of business in force, expected future persistency, withdrawals, interest rates and profitability. These assumptions are modified to reflect actual experience when appropriate. Additional amortization of DAC is charged to current earnings to the extent it is determined that future premiums or gross profits are not adequate to cover the remaining amounts deferred. Changes in actual persistency are reflected in the calculated DAC balance. Costs that are not directly associated with the acquisition of new business are not deferred as DAC and are charged to expense as incurred. Generally, annual commissions are considered expenses and are not deferred.

DAC for group and individual disability insurance products and group life insurance products is amortized over the life of related policies in proportion to future premiums. We amortize DAC for group disability and life insurance products over the initial premium rate guarantee period, which averages 2.5 years. DAC for individual disability insurance products is amortized in proportion to future premiums over the life of the contract, averaging 20 to 25 years with approximately 50% and 75% expected to be amortized by years 10 and 15, respectively.

Our individual deferred annuities and group annuity products are classified as investment contracts. DAC related to these products is amortized over the life of related policies in proportion to expected gross profits. For our individual deferred annuities, DAC is generally amortized over 30 years with approximately 50% and 95% expected to be amortized by years 5 and 15, respectively. DAC for group annuity products is amortized over 10 years with approximately 80% expected to be amortized by year five.

VOBA primarily represents the discounted future profits of business assumed through reinsurance agreements. We have established VOBA for a block of individual disability business assumed from Minnesota Life Insurance Company ("Minnesota Life") and a block of group disability and group life business assumed from Teachers Insurance and Annuity Association of America ("TIAA"). VOBA is generally amortized in proportion to future premiums for group and individual disability insurance products and group life products. However, the VOBA related to the TIAA transaction associated with an in force block of group long term disability claims for which no ongoing premium is received is amortized in proportion to expected gross profits. If actual premiums or future profitability are inconsistent with our assumptions, we could be required to make adjustments to VOBA and related amortization. The VOBA associated with the TIAA transaction is amortized in proportion to expected gross profits with an amortization period of up to 20 years. For the VOBA associated with the Minnesota Life block of business assumed, the amortization period is up to 30 years and is amortized in proportion to future premiums. The accumulated amortization of VOBA was $68.7 million and $65.4 million at December 31, 2013 and 2012, respectively.

The following table sets forth the amount of DAC and VOBA balances amortized in proportion to expected gross profits and the percentage of the total balance of DAC and VOBA amortized in proportion to expected gross profits:

                                December 31, 2013                   December 31, 2012

 (Dollars in millions)      Amount          Percent            Amount           Percent


 DAC                     $       80.1             25.1 %     $       60.9             21.4 %
 VOBA                             4.3             21.4                5.9             25.2

2013 ANNUAL REPORT 21


Table of Contents

Part II

Key assumptions, which will affect the determination of expected gross profits for determining DAC and VOBA balances, include:

Persistency.

Interest rates, which affect both investment income and interest credited.

Stock market performance.

Capital gains and losses.

Claim termination rates.

Amount of business in force.

These assumptions are modified to reflect actual experience when appropriate. Although a change in a single assumption may have an impact on the calculated amortization of DAC or VOBA for balances associated with investment contracts, it is the relationship of that change to the changes in other key assumptions that determines the ultimate impact on DAC or VOBA amortization. Because actual results and trends related to these assumptions vary from those assumed, we revise these assumptions annually to reflect our current best estimate of expected gross profits. As a result of this process, known as "unlocking," the cumulative balances of DAC and VOBA are adjusted with an offsetting benefit or charge to income to reflect changes in the period of the revision. An unlocking event generally occurs as a result of actual experience or future expectations differing from previous estimates. We recorded a reduction to VOBA of $1.0 million in 2013 and $0.8 million in 2012 due to changes in expected gross profits related to a block of claims assumed. We did not record a similar impairment for 2011. As a result of unlocking, the amortization schedule for future periods is also adjusted.

The following table sets forth the impact of unlocking on DAC and VOBA balances:

                                                                      Years ended
                                                                      December 31,

(Dollars in millions)                2013          Dollar Change         2012          Dollar Change          2011


Decrease to DAC and VOBA          $       1.7     $           ---     $       1.7     $           0.8     $       0.9

Significant, unanticipated changes in key assumptions, which affect the determination of expected gross profits, may result in a large unlocking event that could have a material adverse effect on our financial position or results of operations. However, future changes in DAC and VOBA balances due to changes in underlying assumptions are not expected to be material.

Our other intangible assets are subject to amortization and consist of certain customer lists from an Asset Management business acquired and an individual disability marketing agreement. Customer lists have a combined estimated weighted-average remaining life of approximately 6.8 years. The marketing agreement accompanied the Minnesota Life transaction and provides access to Minnesota Life agents, some of whom now market Standard's individual disability insurance products. The Minnesota Life marketing agreement will be fully amortized by the end of 2023. The accumulated amortization of other intangible assets was $42.6 million and $36.5 million at December 31, 2013 and 2012, respectively.

Reserves for Future Policy Benefits and Claims

Reserves include policy reserve liabilities and claim reserve liabilities and represent amounts to pay future benefits and claims. Claim reserve liabilities are for claims that have been incurred or are estimated to have been incurred but not yet reported to us. Policy reserve liabilities reflect our best estimate of assumptions at the time of policy issuance including adjustments for adverse deviations in actual experience.

The following table sets forth total reserve balances by reserve type:

                                             December 31,
                   (In millions)         2013             2012


                   Reserves:
                   Policy reserves   $    1,073.3     $    1,072.0
                   Claim reserves         4,773.6          4,771.2

                   Total reserves    $    5,846.9     $    5,843.2

Developing the estimates for reserves, and thus the resulting impact on earnings, requires varying degrees of subjectivity and judgment, depending upon the nature of the reserve. For most of our reserves, the reserve calculation methodology is prescribed by various accounting and actuarial standards, although judgment is required in the determination of assumptions used in the calculation. We also hold reserves that lack a prescribed methodology but . . .

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